Until now, the People's Republic of China has not been a hotbed of asset-backed issuance. Unlike its neighbors Japan and South Korea, where the number of real or quasi-securitizations has skyrocketed over the past year, ABS remains a new concept for Chinese issuers, and poses a daunting challenge for bankers trying to execute deals there.
Only a few deals have been executed in China so far, all of them privately placed. Last September, China Ocean Shipping (Group) Co. (Cosco) issued its second securitization, a $300 million future shipping receivables-backed transaction arranged by Chase Manhattan Asia, which had spent nearly two years in the pipeline. In addition, ABN Amro has been working on a handful of deals involving China-originated export trade receivables, which are reportedly destined for the bank's commercial paper conduits.
Though quiet for now, China will no doubt become an ABS powerhouse in the long term, agree asset-backed pros in Asia. The sheer size of its market, the huge volume of exports and the wide range of asset types will spur a securitization market that will eventually rival that of Japan, currently the region's biggest issuer.
"China has the greatest potential for asset-backed issuance out of Asia excluding Japan," predicted Paul Kruger, partner at Clifford Chance in Hong Kong. "There is a tremendous amount of foreign currency receivables from manufacturers and companies like Cosco, which provide the obligations that can be the subject of an asset-backed deal."
Overseas ABS More Likely, for Now
Though other Asian countries such as Korea and Singapore have devised quasi-securitizations issued in the domestic market as a stepping-stone to full-fledged, cross-border securitizations, the same scenario is unlikely to unfold in China.
China's currency, the yuan, remains inconvertible outside the country, making it illiquid for international investors. For that reason, most of China's potential in the near term lies in cross-border deals involving well-known originators with U.S. dollar assets, such as exporters with future hard-currency cash flows or financial institutions with portfolios of syndicated loans and bonds, said Paul Burke, head of global securitized finance in Asia for Chase. For example, the Cosco deal is backed by 11 different currencies from OECD countries that required no swapping.
But China remains an extremely tough sell for most international investors, though they are more likely to entertain a securitization from a well-known originator such as Cosco. "There is no question that investors are still nervous about China. One thing that would be important in any Chinese ABS deal is that the originator is an important one to China and the Chinese government. The fact that Cosco comes from a pillar industry like shipping definitely helped investors get more comfortable," Burke added.
In fact, name recognition as well as asset quality will be a key test in future cross-border China ABS deals. "The next deals from China are going to come from issuers that fit Cosco's profile," predicted Diane Lam, director of structured finance ratings at Standard & Poor's in Hong Kong. "They will come from high-visibility companies with export flows and long track record of doing business and bank dealings outside China in the cross-border market."
Domestic Issuance Still Dodgy
A fundamental reason why overseas issuance will occur before a domestic asset-backed market develops is because the legal and financial infrastructure needed for domestic issuance simply does not yet exist. "Looking at the long-term potential for securitization in the region, China offers the longest way to go in legal reform but also offers the greatest opportunity," said Min Ye, vice president of Moody's Investors Service in Hong Kong.
Unlike Korea, where the 1997-98 financial crisis paved the way for swift passage of an asset-backed securitization law, China has not yet created any laws in this area. And though Chinese government officials are keen on securitization as a financing tool in the domestic market, there is no ministry actively promoting ABS, in the way that the Reserve Bank of India or the Thai Securities and Exchange Commission have recently done in their respective countries.
Many legal issues must be addressed before domestic issuance can happen, which will take several years to resolve. First, China's corporate bankruptcy laws are still underdeveloped, as shown by last year's failure of Guangdong International Trust and Investment Corp. (Gitic), which is testing China's bankruptcy laws for the first time in any meaningful way.
"There are a lot of very positive lessons arising from the Gitic bankruptcy, such as what interests will be protected and what interests will not. We are beginning to see the real boundary lines. But the concept of individual bankruptcy and its practical framework is even less developed", added Robert Caldwell, a solicitor at Clifford Chance in Hong Kong.
"Even if the market for credit cards and other more conventional assets develops in the next few years, the extent to which you can enforce against a Chinese individual is difficult to determine, given that individual bankruptcy laws are even less developed than corporate bankruptcy laws. And if you're doing a mortgage-backed securitization, you've got to work out if you can get comfortable enforcing a mortgage under Chinese law. There are fundamental issues still with the legal framework as to how efficient that would be," he explained.
Setting up a domestic special purpose company for onshore issuance is also problematic, since laws for establishing limited liability companies are also undeveloped, and there is no legal concept of trusts, said another capital markets lawyer in Hong Kong. And finally, China does not have a deep enough investor base to buy such issues, nor an active corporate bond market where they can be traded.
Another hurdle is that the universe of potential issuers is fragmented. Large pools of assets are not limited to a handful of companies but to thousands of exporters scattered around the country, noted Christopher Chau, director of international structured finance at Fitch IBCA in Hong Kong.
It is no wonder, given all these problems, that many firms have chosen to wait on the sidelines, rather than rush into China looking for business. "The legal and regulatory environment is a major hurdle and something we're not interested in tackling right now. There's some sense in pursuing export deals like Cosco, but the process is very long and complicated, and we don't think you can do anything domestically in the medium term," said one Asian ABS head at a European firm, echoing a common sentiment.
Legal and Regulatory Matters
China's complex bureaucracy and approval process ensures that executing asset-backed deals is not a quick or easy matter. "The Gitic issue raised many concerns for foreign investors and financiers, but has also provided many important lessons. It reinforces the idea that if you haven't structured the deal properly under PRC law, you're nowhere. You cannot afford to cut corners in Chinese deals," noted Caldwell.
One body whose approval is essential for any asset-backed deal is the State Administration of Foreign Exchange (SAFE), which enforces the rules for repatriation of foreign exchange earnings and approves all foreign exchange transactions. "Our dealings with SAFE on securitization transactions have been extremely positive and constructive, and SAFE appears keen for the right deals to take place. They are very eager to see issuers with good reputations come to market," said Kruger. Another body whose approval may be required is the State Owned Assets Administration Bureau, which must appraise the deal if it involves state-owned assets.
The ability of foreign investors to get comfortable with a true sale opinion given by local counsel and overall legal risk in China are other stumbling blocks to Chinese ABS deals, said some sources. "Rating agencies and investors are not as familiar with the Chinese legal system. Let's just say a true sale opinion from a Chinese lawyer is not going to be respected like a true sale opinion from Hong Kong," said one.
However, obtaining a relatively clean true sale opinion by Chinese counsel is possible, said Kruger. "It comes down to how comfortable foreign investors are with the Chinese legal system as a whole, rather than if they can get comfortable with the true sale issue. There's very little experience in enforceability [but] all we can do is assume that the PRC counsel have their opinion right," he concluded.